27 Business combinations IFRS 3 A Key points When businesses are taken over or merged there are many possible ways of accounting. Mergers are banned it is considered there will always be a dominant acquirer. Up to date and fair values have to be used for the acquired entity s assets. B What does the IAS contain? OBJECTIVE 1 SCOPE 2 IDENTIFYING A BUSINESS COMBINATION 3 THE ACQUISITION METHOD 4 53 Identifying the acquirer 6 7 Determining the acquisition date 8 9 Recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree 10 31 Recognition principle 10 17 Recognition conditions 11 14 27 BUSINESS COMBINATIONS IFRS 3 231
Classifying or designating identifiable assets acquired and liabilities assumed in a business combination 15 17 Measurement principle 18 20 Exceptions to the recognition or measurement principles 21 31 Exception to the recognition principle 22 23 Contingent liabilities 22 23 Exceptions to both the recognition and measurement principles 24 28 Income taxes 24 25 Employee benefits 26 Indemnification assets 27 28 Exceptions to the measurement principle 29 31 Reacquired rights 29 Share-based payment awards 30 Assets held for sale 31 Recognising and measuring goodwill or a gain from a bargain purchase 32 40 Bargain purchases 34 36 Consideration transferred 37 40 Contingent consideration 39 40 Additional guidance for applying the acquisition method to particular types of business combinations 41 44 A business combination achieved in stages 41 42 A business combination achieved without the transfer of consideration 43 44 Measurement period 45 50 Determining what is part of the business combination transaction 51 53 Acquisition-related costs 53 SUBSEQUENT MEASUREMENT AND ACCOUNTING 54 58 Reacquired rights 55 232 THE COMPLETE GUIDE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
Contingent liabilities 56 Indemnification assets 57 Contingent consideration 58 DISCLOSURES 59 63 C Why needed The majority of business combinations are the result of one entity bidding for and taking over another entity one entity purchases another. This Standard requires all business combinations to be accounted for by applying the purchase method acquisition accounting. The Standard setters require that an acquirer be identified they state that there is no such thing as a merger or combining of interests. Acquired assets should be disclosed at fair value on acquisition and any goodwill arising recognised as an asset in the balance sheet. Goodwill is to remain in the balance sheet at cost subject to any write down required as a result of a normally annual test for impairment. Acquisition accounting is the one acceptable method. It is feasible that two businesses could combine their interests and merge. So why do the Standard setters deny the possibility? Merger accounting allows net assets to be combined at their (historical) values as per individual companies accounts. Since neither takes over the other no revision of the combined assets to fair value is needed and no goodwill arises. The combined business balance sheet is likely to have out of date and understated net assets this offends the Standard setters. Pooling of interests or merger accounting has for some time not been permitted in the US, Australia and other countries, and thus an important reason for the issuing of this standard is to achieve convergence. 27 BUSINESS COMBINATIONS IFRS 3 233
D Ideas concepts Acquisition accounting and Goodwill The concept is that there will always be one company taking over another. Fair values should be assigned to the acquired company s assets and any premium paid above this amount is goodwill arising on acquisition. This goodwill is an asset that as been paid for either with cash or by share issue. Goodwill is the generic term. Specific examples of what underlies goodwill are trade names, brands, patents, customer base and know how, or a good management team. The Standard requires that goodwill is shown as an asset and any write downs (impairments) are charged to the income statement. This standard is one of several that pursue the move to make balance sheets more valuation statements balance sheets with more up to date values. Goodwill will remain in the balance sheet at cost. This implies that the name, brand, patents or whatever constituted the goodwill will be supported, by say advertising or development costs. However if goodwill and other intangibles are not supported or become out of date or obsolete then the assets are considered to be impaired. The Standard does not permit calculation and recognition of appreciation in the value of goodwill are the Standard setters being too prudent or are they preventing the opening of a Pandora s box of spurious revaluations? Goodwill is the most elusive of all business assets. Mergers If merger accounting was allowed the combined business balance sheet would have out of date and understated net assets this offends the Standard setters. Another argument in favour of disallowing merger accounting is the fact that there are probably very few cases, at least of listed companies, where there is a true merger. There will always be a take-over of one business by the other. 234 THE COMPLETE GUIDE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
E Key Content of the Standard Objective 1 The objective of this IFRS is to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statement about a business combination and its effects. To accomplish that, this IFRS establishes principles and requirements for how the acquirer: a) recognises and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; b) recognises and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Definitions Acquiree. The business or businesses that the acquirer obtains control of in a business combination. Acquirer. The entity that obtains control of the acquiree. Acquisition date. The date on which the acquirer obtains control of the acquiree. Business. An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants. Business combination. A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals are also business combinations as that term is used in this IFRS. 27 BUSINESS COMBINATIONS IFRS 3 235
Contingent consideration. Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met. Control. The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Equity interests. For the purposes of this IFRS, equity interests is used broadly to mean ownership interests of investor-owned entities and owner, member or participant interests of mutual entities. Fair value. The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. Goodwill. An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. Identifiable. An asset is identifiable if it either: a) is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. Intangible asset. An identifiable non-monetary asset without physical substance. Mutual entity. An entity, other than an investor-owned entity, that provides dividends, lower costs or other economic benefits directly to its 236 THE COMPLETE GUIDE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
Owners, members or participants. For example, a mutual insurance company, a credit union and a co-operative entity are all mutual entities. Non-controlling interest. The equity in a subsidiary not attributable, directly or indirectly, to a parent. Owners. For the purposes of this IFRS, owners is used broadly to include holders of equity interests of investor-owned entities and owners or members of, or participants in, mutual entities. Required Practice IDENTIFYING A BUSINESS COMBINATION 3 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this IFRS, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. Paragraphs B5 B12 provide guidance on identifying a business combination and the definition of a business. THE ACQUISITION METHOD 4 An entity shall account for each business combination by applying the acquisition method. 5 Applying the acquisition method requires: a) identifying the acquirer; b) determining the acquisition date; c) recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and d) recognising and measuring goodwill or a gain from a bargain purchase. 27 BUSINESS COMBINATIONS IFRS 3 237
Identifying the acquirer 6 7 6 For each business combination, one of the combining entities shall be identified as the acquirer There will ALWAYS be a takeover mergers are not allowed. Determining the acquisition date 8 9 The acquirer shall identify the acquisition date, which is the date on which it obtains control of the acquiree. Recognition principle 10 As of the acquisition date, the acquirer shall recognise, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. Recognition of identifiable assets acquired and liabilities assumed is subject to the conditions specified in paragraphs 11 and 12. Recognition conditions Classifying or designating identifiable assets acquired and liabilities assumed in a business combination 15 At the acquisition date, the acquirer shall classify or designate the identifiable assets acquired and liabilities assumed as necessary to apply other IFRSs subsequently. The acquirer shall make those classifications or designations on the basis of the contractual terms, economic conditions, its operating or accounting policies and other pertinent conditions as they exist at the acquisition date. Measurement principle 18 The acquirer shall measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values. Fair values (up to date values) must be used 238 THE COMPLETE GUIDE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
Recognising and measuring goodwill or a gain from a bargain purchase 32 The acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below: a) the aggregate of: i) the consideration transferred measured in accordance with this IFRS, which generally requires acquisitiondate fair value (see paragraph 37); ii) the amount of any non-controlling interest in the acquiree measured in accordance with this IFRS; and iii) in a business combination achieved in stages (see paragraphs 41 and 42), the acquisition-date fair value of the acquirer s previously held equity interest in the acquiree. b) the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this IFRS. SUBSEQUENT MEASUREMENT AND ACCOUNTING 54 In general, an acquirer shall subsequently measure and account for assets acquired, liabilities assumed or incurred and equity instruments issued in a business combination in accordance with other applicable IFRSs for those items, depending on their nature. However, this IFRS provides guidance on subsequently measuring and accounting for the following assets acquired, liabilities assumed or incurred and equity instruments issued in a business combination: a) reacquired rights; b) contingent liabilities recognised as of the acquisition date; c) indemnification assets; and d) contingent consideration. 27 BUSINESS COMBINATIONS IFRS 3 239
DISCLOSURES 59 The acquirer shall disclose information that enables users of its financial statements to evaluate the nature and financial effect of a business combination that occurs either: a) during the current reporting period; or b) after the end of the reporting period but before the financial statements are authorised for issue. 61 The acquirer shall disclose information that enables users of its financial statements to evaluate the financial effects of adjustments recognised in the current reporting period that relate to business combinations that occurred in the period or previous reporting periods. F Significant differences in GAAP US GAAP From July 2009 the US and IFRS standards are virtually converged. UK GAAP The UK standard FRS 2 requires exclusion from consolidation where severe long term restrictions hinder effective control. IAS 27 does not have such an exclusion. Under FRS 2 goodwill previously written off to reserves is included in the calculation of a gain or loss on disposal. IAS 27 excludes from the calculations goodwill previously written off to equity. 240 THE COMPLETE GUIDE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS